Selection on Projects using NPV, IRR and Payback

There are two independent investment projects for the Galactic Empire. Project A costs the Empire $300,000 to set up, and it will provide annual cash inflows of $70,000 for 7 years. Project B costs the Empire $1,000,000 to set up, and it will provide annual cash inflows of $255,000 for 6 years. The Empire's cost of capital (i.e., the required return on investment) is 10% annually, and the Empire requires the initial investments in those projects be fully paid back within 4 years, or it will be running out of money by then.

Based on the NPV rule, what project(s) should the Empire accept?
a. Project A only.
b. Project B only.
c. Both Projects A and B.
d. Neither Project A or B.

Based on the IRR rule, what project(s) should the Empire accept?
a. Project A only.
b. Project B only.
c. Both Projects A and B.
d. Neither Project A or B.

Based on the Payback rule, what project(s) should the Empire accept?
a. Project A only.
b. Project B only.
c. Both Projects A and B.
d. Neither Project A or B.

Based on your answers to Q13-15, what project(s) should the Empire finally choose?
a. Project A only.
b. Project B only.
c. Both Projects A and B.
d. Neither Project A or B.

Solution Preview

Based on the NPV rule, what project(s) should the Empire accept?

We calculate the NPV of the two projects
NPV of A is -300,000 + 70,000 X PVIFA (7,10%) = $40,789.32
NPV of B is -1,000,000 + 255,000 X PVIFA (6,10%) = $110,591.48

Since the projects are ...

Solution Summary

The solution explains how to select projects under NPV, IRR and Payback methods

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